Spring 2012
Income Tax Valuation Issues Insights Editors for This Issue: Robert F. Reilly, CPA, and Seth Palatnik, CPA
Thought Leadership:
Overcoming Obstacles in the
Intellectual Property Transfer Price Analysis
Aaron M. Rotkowski and Scott R. Miller
When a multinational corporation develops and owns intellectual
property that is used
by its controlled foreign subsidiaries, a reasonable intercompany transfer price should be
established as a charge for the use of the intellectual property. The purpose of such an
intercompany transfer price is to ensure that the appropriate amount of taxable income
is recognized—and the appropriate amount of income tax is paid—in each national
taxing jurisdiction. The intercompany transfer price should reflect an arm’s-length price
(ALP) that unrelated parties would agree to for the use of similar intellectual
property. The
Internal Revenue Service provides guidance on the procedures to estimate the intellectual
property intercompany transfer price in such a situation. However, the analyst is likely
to encounter unique circumstances in each individual case. This discussion addresses
issues that the analyst may encounter when applying the procedural guidance provided
by Internal Revenue Code Section 482 (and the corresponding Regulations) with regard
to the calculation of a fair, arm’s-length royalty rate for the intercompany transfer of
intellectual property.
Valuation Issues in the C
Corporation to
S Corporation Conversion
David M. Chiang
Income Tax Valuation Insights
This discussion addresses the valuation issues related to the federal income tax
conversion
from C corporation status to S corporation status. These valuation issues include (1) the
eligibility requirements for a C corporation taxpayer to convert to S corporation status,
(2) the application of a valuation discount for lack of marketability, (3) the valuation
consideration of the built-in gains tax liability, and (4) the appropriate standard of
value to
apply in the C corporation to S corporation conversion valuation.
Buyers and Sellers of an S
Corporation
Should Consider the Section 338 Election
Robert P. Schweihs
There are a variety of factors that buyers and sellers consider when deciding whether the
acquisition of a 100 percent ownership interest in the target company should be structured
as an acquisition of target company equity or as the purchase of target company assets. If
the target company is an S corporation for federal income tax purposes, there is a federal
income tax opportunity to achieve the best of both worlds—that is, the acquisition of the
target company equity treated as a purchase of the target company assets. That federal
income tax structure could have a favorable impact (1) on the transaction’s after-tax sale
proceeds to the seller and (2) on the transaction’s after-tax cost to the
buyer.
Sale of the Closely Held
Business—
Personal Intangible Assets versus
Company Intangible Assets
Chip Brown, CPA
Prior to the sale of a closely held C corporation, the seller corporation’s financial
advisers
should consider any personal intangible assets that may be operated by the corporation.
A “personal intangible asset” is an intangible asset that is created and owned by the
corporation owner—but is used by the subject corporation. Personal intangible assets
may exist when a shareholder’s personal reputation, industry expertise, and/or business
relationships contribute significantly to the company business value and expected future
cash flow. This discussion summarizes what the closely held corporation owner should
consider regarding the identification and documentation of personal intangible assets,
particularly with respect to structuring the sale of the closely held C
corporation
Implications of the America
Invents Act
for Income Tax Patent Valuations
Ashley L. Reilly
On September 16, 2011, President Obama signed into law the America Invents Act (the
“AIA”). The AIA represents the result of many years of patent reform efforts. And, in
fact,
the AIA provisions do provide significant changes related to (1) the patent application
process, (2) the process for challenging pre-issuance and post-issuance patents, and (3)
litigation related to various types of patent claims. Taxpayer patents (and other taxpayer
intellectual property) are frequently the subject of valuation for a variety of federal
income
tax purposes. This discussion lists several of these tax-related valuation purposes. The
principal question considered in this discussion is: Will the AIA patent reform affect the
valuation of taxpayer patents for federal income tax purposes?
The Dangers of the New
Functional Risk
Analysis
David Abbott, Esq., Brian Kittle, Esq., and Andrew Steigleder, Esq.
Within the ever-evolving standards and judicial doctrines applied by the courts to
assess the
validity of tax-advantaged transactions, there has been an increasing trend to supplement,
or even abandon, a traditional risk analysis. Rather, the trend is to perform an
analysis that
examines not only whether a risk exists, but also the probability that such risk will
manifest
itself. This new analysis can lead to the application of entirely subjective standards.
Such
subjectivity can create additional uncertainty for taxpayers in structuring and
defending taxadvantaged
transactions.
Tax Considerations of Close
Corporation
Buy/Sell Agreements
Robert F. Reilly, CPA
Valuation analysts are often involved in designing the valuation pricing formula included
in close corporation and professional practice buy/sell agreements. In addition, valuation
analysts are often asked to interpret or implement buy/sell agreements that call for a
“fair
market value” price or a price to be determined by “an independent appraiser.” In addition
to quantifying the pricing aspects of close corporation buy/sell agreements, valuation
analysts should be generally familiar with the taxation aspects of the common types of
buy/
sell agreements. This discussion summarizes the income tax implications of the common
types of buy/sell agreements.
Best Practices
Reasonable Compensation Analysis
for C Corporations and S Corporations
John C. Ramirez
The reasonableness of shareholder/employee compensation is often a highly controversial
issue in the context of federal income taxation. This is because what is considered
reasonable compensation by the shareholder/employee taxpayer is often considered
unreasonable by the Internal Revenue Service (“Service”). According to Internal Revenue
Code Section 162, in order to be deductible for federal income tax purposes, executive
compensation must be (1) “reasonable in amount” and (2) “based on services actually
rendered.” The income tax–related consequences associated with unreasonable shareholder/
employee compensation can be significant (and include payroll taxes, late payments, and
tax return filing penalties). For this reason, it is important that valuation analysts
and other
financial advisers understand the factors that the Service and the federal courts consider
when analyzing the reasonableness of shareholder/employee compensation. This discussion
focuses on the generally accepted factors and methods used to analyze the reasonableness
of shareholder/employee compensation.
Data Sources for Reasonable
Compensation Analyses
Victoria A. Platt
One important component to meeting the Internal Revenue Service standards for proving
the reasonableness of shareholder/employee compensation is relying on credible empirical
data. This discussion introduces the reasonable compensation analytical procedures that
were developed by statutory authority and legal precedent. This discussion also identifies
reliable sources of empirical data for the analyst to use in applying the generally
accepted
reasonableness of compensation methods and procedures.
Section 409A Considerations
and Close
Corporation Stock Option Valuations
Katherine A. Gilbert and C. Ryan Stewart
Internal Revenue Code Section (“Section”) 409A involves the taxation of deferred
compensation such as stock options and stock appreciation rights. Compliance with Section
409A can be challenging for the management of a closely held taxpayer corporation.
Such compliance requires an understanding of the specific Section 409A requirements as
they apply to the valuation of the closely held corporation. This discussion focuses on
the
Section 409A provisions that stipulate the (1) circumstances that require a valuation, (2)
appropriate methods to use when performing the valuation, and (3) selection of qualified
individuals to perform the valuation of the closely held taxpayer corporation common
stock.
Insolvency Procedures under
Section 108
Irina Borushko and Urmi Sampat
In the current prolonged recession, many industrial and commercial entities have had
to restructure their outstanding debt. Many debtor entities have had to restructure their
public bonds as well as their private mortgages and notes. In particular, many real
estateintensive
debtor entities have had to restructure their commercial real estate mortgages.
When any amount of debt repayment is forgiven in such a debt restructuring, that event
causes the debtor entity to recognize cancellation of debt (COD) income for federal income
tax purposes. However, the debtor taxpayer can exclude some, or all, of this COD income
to the extent that the debtor entity is insolvent. This discussion summarizes the federal
income tax requirements related to the debtor entity recognition of COD income. And, this
discussion summarizes the federal income tax requirements for the exclusion of COD income
recognition related to debtor entity insolvency. In particular, this discussion focuses
on the
generally accepted methods and procedures that the valuation analyst may use to measure
debtor entity insolvency for COD income exclusion purposes.
Some Thoughts Regarding
Insolvency and
Bankruptcy Tax Planning
Roger J. Higgins, Esq.
Planning for when a business faces the prospect of an insolvency restructuring, whether
as a bankruptcy case, a state law proceeding, or an out-of-court workout, can be very
complicated. And, the landscape can be as charged as a minefield. Throw in income
tax considerations, and matters become even more interesting. This discussion provides
an overview of some of the more fraught income tax issues that often arise within a
restructuring or insolvency context.
Definition of “Readily
Tradable” Employer
Securities for ESOPs
Robert F. Reilly, CPA
When an employee stock ownership plan (ESOP) owns sponsor company stock that is
not readily tradable, the sponsor company must provide a number of rights to the ESOP
participants (e.g., pass-through voting rights, annual independent appraisals, the retiree
“put option,” etc.). When an ESOP owns sponsor company stock that is readily tradable,
the sponsor company does not need to provide these rights to the plan participants. For
most ESOPs, it is fairly obvious as to whether the ESOP owns private company stock or
public corporation stock. However, for some sponsor companies (e.g., a company with stock
that trades on the OTC Bulletin Board or on a foreign stock exchange), the determination
of “readily tradable” is not always so obvious. Therefore, the Internal Revenue Service
has
issued final rules as to the definition of the term “readily tradable” with regard to
employee
benefit plans.
Lightning Strikes Twice, MRI
Associates
Wins Big Again—Halloween Verdict Proves
to Be Frightening to Regional Health System
Charles A. Wilhoite, CPA
On October 31, 2011, MRI Associates, Inc. (MRIA) was awarded $52 million in economic
damages by an Idaho jury for claims relating to a variety of alleged breaches on the part
of Saint Alphonsus Diversified Care, Inc., and Saint Alphonsus Regional Medical Center
(collectively, “SARMC”). The breaches related to a magnetic imaging joint venture. The
verdict represented the second time in four years that an Idaho jury ruled in favor of
MRIA
regarding substantially the same complaint. This discussion presents the key facts and
circumstances regarding the case, with an emphasis on the damages models and related
opinions offered by the financial experts retained by each party.